MGEB06H3 Lecture Notes - Lecture 8: Counterargument, Output Gap, Loanable Funds

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22 Feb 2017
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Macroeconomics Notes: Lecture Eight (Chapter Thirteen) PART1:
Fiscal Policy: The Basics
Fiscal policy refers the government’s choice regarding levels of spending, taxes, and transfers.
The use of taxes, government transfers or government purchases of goods and services to
stabilize the economy by shifting the aggregate demand curve
Taxes, Purchases of Goods & Services, Government Transfers, and Borrowing
Taxes are the “income” of the government.
Taxes include income taxes, corporate profit taxes, sales taxes, social insurance taxes (e.g.,
payroll taxes), and other taxes (e.g., property taxes).
Government expenditures come into two forms:
1) Government spending on final goods and services (G). such as, buying new office supplies.
2) Government transfers (TR) payments to households for which no good and service is
provided in return. Examples, childcare benefits, employment insurance and etc.
The Government Budget and Total Spending
The national income identity: GDP = C + I + G + X IM = AEPlanned
Effects of fiscal policy:
Direct effect: Changing government spending on final goods and services (G).
Indirect effect: Indirectly changes in taxes and government transfers.
By changing taxes and government transfers, the government changes households’
disposable income (YD = Y T + TR) a in YD leads to a in C.
Implication: Change in fiscal policy will affect AEPlanned both the AEPlanned line and the AD
curve will shift there will be changes in the short-run level of output.
Inflationary gap: occurs when aggregate output exceeds potential output such as, gaps,
created when output is nit at the economy’s full employment level and harmful to the welfare
of households and firms.
Income-expenditure model equilibrium equation:
Y = AC + AI + G + X0 IM0 + MPC×TR0 MPC×T0 di + MPC×(1ttr)×Y
Y* = [AC + AI + G + X0 IM0 +MPC×TR0 MPC×T0 di]

AE0 The multiplier
Effectiveness of Fiscal Policy
Expansionary and Contractionary Fiscal Policy
Since changes in G, T0, and TR0 lead to changes in AE0, changes in fiscal policy will shift the
AEPlanned and AD curves changes in Y (Chapter 12)
Changes in fiscal policy that will lead to an increase in output is called expansionary fiscal
policy (i.e., G , T0 , TR0 ).
Changes in fiscal policy that will lead to a decrease in output is called contractionary fiscal
policy (i.e., G , T0 , TR0 ).
Expansionary fiscal policy: is the fiscal policy that increases aggregate demand
Contractionary fiscal policy: is fiscal policy that reduces aggregate demand.
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